Many years ago, a company that manufactured outdoor products that it sold in hardware stores across America came to us with the following problem:

Its Chinese manufacturer had (through a straw person) registered in China about a dozen trademarks that our new client used on its outdoor products.  More importantly, the Chinese manufacturer had just informed our new client that it would no longer be manufacturing these outdoor products for our client because it was now going to be selling them directly to the same hardware stores to which our client had been selling the products.


The Chinese company never sold even one single product to anyone in the United States and in the end it lost tens of millions of dollars a year in revenue by having so unceremoniously cut-off our client.  The Chinese company failed to sell any products to US hardware stores because it had zero clue what it takes to sell its products in the United States.  The Chinese company went to the various hardware stores in the United States that had been selling “its” products and told them that it would now be able to sell them the exact same products for around 50% less.  But when the US hardware store chains asked the Chinese company about the systems it had in place to make sure that each and every one of its stores would always have the right number of outdoor products in stock (i.e., what inventorying system it would be using) the Chinese company had no real reply.  And when the US hardware store chains asked the Chinese manufacturer how it would handle product repairs and returns it had no answer for that either.

We worked with our client and figured out how to get around the Chinese trademarks the Chinese manufacturer had filed. To make a long story short, it had failed to trademark all of any one product and we were able to secure China trademark registrations for parts of the whole and it was on those parts that our client prominently put its trade name, after registering those trade names in China.

I thought of that Chinese outdoor products manufacturer today when I read a ZDNet article entitled, Big CES push from Chinese phonemakers, but tough sell in US. The gist of the article is that China is making excellent cellphones and smart phones these days but it has yet to sell anything but a handful of its phones in the United States and the big reason for much the same reasons why the Chinese outdoor products manufacturer failed to sell its own branded products:

“It’s one thing to have the product. It’s another thing to have all the relationships, build the distribution channels and do the marketing,” Frank Gillett, an analyst with Forrester Research, told the newswire. A partnership is particularly important in the U.S. where the majority of users buy heavily subsidized devices through carriers.

I have seen this same sort of thing in other industries in the United States where my law firm has represented Chinese companies unwilling to do what it takes to sell their China branded products in the United States.  These companies have been unwilling to spend the kind of money required to market or distribute their products in the United States and, perhaps most importantly, they have been unwilling to hire top-tier people in the United States who know how to market to US consumers.  I have heard countless similar stories from other service companies that work with Chinese companies trying to mark into the US market.

Succeeding at selling consumer products (really most products) in the United States virtually always requires more than just having the lowest price.  Unless and until Chinese companies truly understand this (rather than paying it mere lip service), the threat of Chinese companies taking over the US consumer market is minimal at best.

Just saying….

What do you think?


Ancient as it may seem, this blog still has around 1,000 people who read us via email.  Many of those readers have been subscribing virtually since our inception in January, 2006.  What I have always liked about email subscribers is their ability to respond directly to us (and our posts) simply by writing a responsive email.  The typical email might be something really short, like “I agree” or “I have been seeing the same thing” or even an occasional “this is wrong.”

Anyway, I got an interesting two emails yesterday.  One was from an email subscriber, a solo practitioner who is learning Chinese in Pittsburgh, PA (yes, I know most of you know that Pittsburgh is in Pennsylvania, but as someone who listens to E Street Radio pretty much every day, I can’t say Pittsburgh — even in my head — without adding P.A.), asking us to write about getting Chinese clients.  The other was from a young lawyer in New York City, about to go to China, asking us essentially the same thing.

I responded to the New York lawyer via email and I am going to give a similar response to the Pittsburgh, PA, lawyer here.

I don’t know.  When it comes to China, my firm’s focus is on mostly American (that includes Canada and Latin America) and European companies looking to go into China, looking to do business with China, already in China, or already doing business with China. Less than one percent of our “China work” involves companies from China.  We long ago determined that our time would be better spent focusing on representing companies from these countries than from China.

Though we do from time to time get business from Chinese companies, that work has nearly always come as referrals from Chinese lawyers with whom we regularly work in China or from Chinese (and Chinese-American) businesspeople that we know in the United States. We are certainly not opposed to representing Chinese companies, but we have found far too many of them (including very large companies) to be unsophisticated in how to use American lawyers and unappreciative of what it takes — and, yes, most importantly, what it costs — to practice law in the United States.  Put simply, we have found it to make economic sense (for us) to focus on working with foreign companies going to China, rather than on the reverse.  As a result of that, we are not the people to ask about marketing to Chinese clients.

So people, especially you lawyers out there that represent Chinese clients, can you help?  How do you get your Chinese clients?  Do you market to them mostly in China or in the US?  What are Chinese companies looking for in an American law firm?  Does a solo practitioner have a chance?  What about small law firms?

If you are not a member of our China Law Blog Group on Linkedin, you should be. Put simply, we have great discussions on China law and China business among our 7600+ members and there is never any spam. I guarantee it.

One of our latest and greatest discussions is on a topic near and dear to my heart: litigation versus arbitration in a China contract.  The discussion started with a US lawyer posing the following question: “Should a Contract Between a Non-Chinese Company and a Chinese Company Require Courtroom Litigation or Arbitration?”  He then went on to sort of answer it himself, with the following:

It seems to me under the NY Convention of 1958 that the following should be the practice of writing contracts:  1) If the dispute is over money damages only – Arbitration OUTSIDE of China is the best practice (Chinese courts have never rejected such arbitration awards and enforce them. 2) If the dispute is over money and personal property (molds for instance) then using Chinese courts is the preferred method.  Counter-argument(s)?

I disagree somewhat in that Chinese courts oftentimes do not enforce foreign (and domestic) arbitration awards. The statistics on this look better than they should because Chinese courts oftentimes will “reject” a foreign arbitral award not by writing an opinion explicitly declining to adopt the foreign arbitration award, but by simply never writing any opinion at all, which itself acts not to enforce the award.

Another US lawyer then said that she thought Hong Kong arbitration makes sense and that China courts are to be avoided. I disagree with this in that even if true, many Chinese companies will not agree to arbitration, but I also disagree with this because Chinese courts do not have all that great a record in enforcing foreign arbitration awards.

A US law intern then said that he “would always use an arbitration clause in any international contract, no matter what the contract was for. Particularly with China, since they are signatories (essentially) to the New York Convention, any arbitration award should be enforceable in Chinese courts, no matter what the contract is for.”  This answer makes some sense on paper, but it fails to account for what actually happens in real life.

A China and New York licensed lawyer then said that the distinction between a money damages and personal property contract is not a good method for determining whether to arbitrate or litigate.  I agree.

A US lawyer then said that he “always” recommends “arbitration” because … the Chinese court system is too unpredictable and too corrupt.”  See my thoughts above.

A Chinese lawyer then said that most Chinese courts are not unpredictable, especially when dealing with clear-cut issues and that “litigation could be pressure for a Chinese company.”  I agree and note that this raises an absolutely essential point.  I am always telling our clients and I am always blogging on the benefits of a good contract with your Chinese counter-party that go beyond the ability to sue and enforce. In Chinese Contracts. Because They Really Do Make A Huge Difference, I set out these three reasons, with one of them being to “put a little scare into your Chinese counter-party”:

The third reason to have a good contract is to put a little scare into your Chinese counter-party.  I call this the “bike-lock theory of Chinese contracts” and I wrote about this too way back in 2006, in China OEM the Smart Way:

The best solution for this is to prevent it from happening in the first place and the best way to do that is to choose the right supplier and use a good OEM contract.  When we draft OEM contracts for our clients, we always put in a provision precluding the Chinese manufacturer from subcontracting out production. Without exception, the Chinese manufacturers have agreed to this provision and, again without exception (at least as far as we know), they have always abided by it.  The reason for this is simple.  The manufacturer may have twenty some companies for whom it produces goods, but probably less than half of them forbid subcontracting.  When the Chinese manufacturer is so busy as to require subcontracting, it makes sense for it to first subcontract out work for those foreign companies for whom it is NOT prohibited by contract from doing so.  I am always analogizing this to bike locks.  Even the best bike lock cannot prevent all thefts, but its efficacy comes from the fact that bike thieves generally find it easier to steal a bike with a poor quality lock or none at all than one that is difficult to break.

Any contract that makes your Chinese counter-party think twice about messing with you has at least some value.  My law firm is constantly settling cases with Chinese companies based on well-written contracts.  Chinese company clearly owes our client a million dollars per a well written contract and we settle for $650,000.  Had it been in the United States, we might not have taken less than $850,000.  But had there been no contract, my firm would not have even taken the case and settlement would likely have been for nothing at all or something really nominal.

Having a well written contract does not mean you will always win your lawsuit if you are forced to sue on it. But it does mean you will have some leverage if things go wrong and it does mean you will at least have a chance. Having no contract means no chance. Hey, it’s your choice.

Chinese companies do not like being sued. Just being sued in China is viewed by many companies as damaging to their reputation.  They especially do not like it if they are going to lose and if enforcement is going to be quick. Being sued in a Chinese court is generally viewed by Chinese companies as worse than being pursued by arbitration.

Another Chinese lawyer then said that he prefers arbitration to litigation, but gave no reason why.  Is it simply because he finds arbitration more enjoyable as a lawyer?

An American lawyer turned businessperson then voted for arbitration and mused about the best place.  He pointed out that just about everyone knows about the benefits of Hong Kong, but that he is a fan of Singapore. I do not think arbitration is always the answer, but I am a fan of Singapore over Hong Kong because the lawyers and the arbitrators tend to cost less in Singapore, but I would hesitate to pick it solely on this basis because I have a sense that a Hong Kong arbitration award is more likely to be enforced on the Mainland than a Singapore one.

Then an American lawyer who frequently represents Chinese companies talked of how those companies like US litigation provisions because that increases their chances of being able to enforce a judgment against their American counterpart, but that testifying in a less formal arbitration setting is oftentimes better for Chinese witnesses.  He then concludes that “there are often downsides and upsides to both settings and, therefore, I find the decision to choose the format (if given that opportunity) is fact specific and dependent on the nature of the dispute, the parties, and the forum options.”  I like what he says.

Then a Canadian lawyer, Paul Jones, wrote what I consider to have been the best answer:

For me it depends first on the most likely type of dispute, the desired remedies and the location of assets.

I read Chinese court decisions almost daily and find that they are generally well-reasoned. The decision of the Shanghai Higher People’s Court in the Johnson & Johnson re-sale price maintenance case is an example of a particularly well-written and well-reasoned judgment.

Common lawyers over-emphasize the issue of precedent. Civil law systems, including those of China, have other, more sensitive ways of ensuring that similar cases are decided in similar ways. I was first trained in common law.

Arbitration is good for large cases, where the remedy sought is money and the amount is over $5 million USD.

For amounts below that it should be remembered that it costs almost as much to have an arbitral award enforced by a court in China as it costs to go to trial. And a very basic arbitration can cost several times what it would cost to go to trial in China.

Further if specific remedies such as an IP injunction, or a seizure of certain assets is being sought, only a court can provide these remedies. Certain types of evidence may only be obtained by a Chinese court order. Arbitration outside China just adds substantial delay and risk to the enforcement of your rights.

The enforcement rate for foreign arbitral awards is about 70% to 80%. Not all are enforced. There are papers and books on this topic.

Chinese courts can be much quicker than many foreign courts. Completion of the matter in 6 months is not unusual. As do other civil law courts they rely more on documentary evidence than oral testimony, so usually there is no need for the foreign executive to attend. There is no discovery. You need to plan your evidence well in advance.

The World Bank Doing Business survey ranks the Chinese court system 19th in the World for the enforcement of contracts, based on time required, cost, and complexity of procedures. I think that this ranking reflects the points that I have used above.

My practice consists of a lot of distribution agreements and IP licenses. The amounts in dispute rarely get up to $5 million, the IP needs injunctive remedies, and the Chinese party usually does not have assets outside the country.

So we usually recommend Chinese law and Chinese courts. We have experience litigating in the Chinese courts.

He completely nails it and his comment is very similar to what we tell our clients all the time.  Breaking it down:

  • “For me it depends first on the most likely type of dispute, the desired remedies and the location of assets.”  Exactly.  In figuring out what we are going to put in the contracts we write between our US clients and their Chinese counterparts, we first sit back and try to figure out the most likely breach of contract scenarios (either by our own client or by the Chinese company) and also the really critical breach of contract scenarios.  A bad delivery of $100,000 in product might be very likely, but that is going to pale in importance to the Chinese company taking over our client’s factory in China and ceasing all deliveries.  So between those two, we would probably write the contract to provide our client with the best forum for dealing with its factory being hijacked.
  • “I read Chinese court decisions almost daily and find that they are generally well-reasoned.”  Again, completely agree. Yes, you should think very hard about avoiding a situation where you find yourself in a Chinese court going up against a powerful company owner in some small city in China’s interior, but the judges in China’s larger and more sophisticated cities, particularly in the higher courts, are often not so bad at all.
  • “Arbitration is good for large cases, where the remedy sought is money and the amount is over $5 million USD. For amounts below that it should be remembered that it costs almost as much to have an arbitral award enforced by a court in China as it costs to go to trial. And a very basic arbitration can cost several times what it would cost to go to trial in China.”  I agree, but would hedge it a little by saying that arbitration is “generally” good for large money damages cases.
  • “Further if specific remedies such as an IP injunction, or a seizure of certain assets is being sought, only a court can provide these remedies. Certain types of evidence may only be obtained by a Chinese court order. Arbitration outside China just adds substantial delay and risk to the enforcement of your rights. The enforcement rate for foreign arbitral awards is about 70% to 80%.” I agree and this is key. Much of the time, the biggest risk to the American company is not money, not the one bad shipment, not the long delay.  Much of the time, the biggest risk to the American company is that the Chinese company will run away with the American company’s IP or just keep manufacturing and selling the American company’s product after the American company wants it to stop.  No matter how you slice it, it is going to be faster and easier to get injunctive relief or an injunction equivalent from a Chinese court than from a foreign or even a domestic arbitration panel.  And Jones is absolutely right in pointing out that the enforcement of foreign arbitral awards in China is well under 100%.
  • “Chinese courts can be much quicker than many foreign courts. Completion of the matter in 6 months is not unusual. As do other civil law courts they rely more on documentary evidence than oral testimony, so usually there is no need for the foreign executive to attend. There is no discovery. You need to plan your evidence well in advance. The World Bank Doing Business survey ranks the Chinese court system 19th in the World for the enforcement of contracts, based on time required, cost, and complexity of procedures. I think that this ranking reflects the points that I have used above.”  I completely agree.  We have been involved in cases where the court has granted us our remedy within a couple of months.
  • “My practice consists of a lot of distribution agreements and IP licenses. The amounts in dispute rarely get up to $5 million, the IP needs injunctive remedies, and the Chinese party usually does not have assets outside the country. So we usually recommend Chinese law and Chinese courts. We have experience litigating in the Chinese courts.”  Ditto for my law firm, but I would add in manufacturing contracts to the list where Chinese law and Chinese courts almost always makes sense, and for the same reasons as for the IP contracts. I also want to mention that if your contract is going to call for Chinese law and Chinese courts, you pretty much have to make your contract in Chinese.  For more on how to write a China contract, check out China OEM Agreements. Why Ours Are In Chinese. Flat Out.

In Litigating In China. Don’t Lock Yourself Out, we wrote of how the most common mistake we see with foreign company contracts with Chinese companies:

The most common mistake we see by foreign companies is using a contract that is not enforceable in China. By doing this, they ensure the contract is not enforceable anywhere in the world. How does this happen? They do this by writing a contract with these features:

•  The contract is governed by US law.

• The exclusive forum for dispute resolution is litigation in a US court.

• The language of the contract is English.

Foreign companies are frequently quite proud that they have “forced” the Chinese side of the contract to accept these onerous terms. Apparently they think the terms protect the foreign side because it forces the Chinese side to file a lawsuit outside of China and subjects them to foreign law and procedure. However, this is an illusion. How many times does a Chinese manufacturer file a law suit? The party that will normally want to file a law suit is the buyer of the product, not the seller.

The Chinese side is usually happy to sign an agreement with these dispute resolution terms because it fully understands 1) that if it wants to sue the foreign company, it will need to sue it in their home (foreign) country since very few countries enforce Chinese judgments and 2) it also knows that it will have now ensured that it is nearly free of any risk that an enforceable judgment will be entered against it. In other words, the Chinese company knows that it has just been “forced” by the foreign side to execute an unenforceable contract. Since the terms of the contract cannot be enforced, the Chinese side can then be quite relaxed about the contract terms.

Why does this happen? The reason is that at the start of litigation, a Chinese court will first look at the dispute resolution provisions of the contract. If the contract provides for dispute resolution (litigation or arbitration) outside of China, the court will refuse to hear the case. There are no exceptions to this. With respect to arbitration, as with most countries, Chinese courts will only allow arbitration in China if there is an explicit, exclusive China arbitration provision. A common trap is a contract that provides for an alternative of litigation outside of China or arbitration inside China. In that case, the Chinese courts have traditionally refused to honor a Chinese arbitration award because the arbitration provision is not exclusive.

It is therefore critical for every company that does business in China to ask a fundamental question: if there is a dispute under this agreement, am I most likely to be a plaintiff or a defendant. If your company will be a plaintiff, then you must ensure that your contract is fully enforceable in China. It is a complete disaster to close the door to the Chinese litigation and arbitration by insisting on litigation outside of China. The next step is then to draft your contract to maximize the chance that you will get a good result in China.

Even though this all seems obvious, I find that almost every week I have to give a potential client the bad news that their contract is unenforceable through their own efforts. When I get a call from a client who wants to collect on a debt or resolve a business dispute with a Chinese company, the first thing I ask about is the dispute resolution provisions in their contract. The client then emails me the contract and I discover that the contact is governed by Arizona law with exclusive jurisdiction in the Arizona courts. I then ask: does the potential defendant have any assets in the US The answer to this question is nearly always “no,” at which point I then have to tell them that their contract is unenforceable and they will have to consider another method for resolving their dispute. This is usually a conclusion that causes distress for the client, because this kind of provision is often included at the tail end of a long and detailed (and expensive) 50 page contract. Needless to say, it is much better to have a 7 page contract that you can enforce than a 50 page contract that is waste paper.

I hate to say this, but I think that the foreign arbitration versus China litigation split oftentimes is between law firms who are not comfortable working with Chinese language documents and law firms calling for Hong Kong arbitration on the one hand, and law firms that are comfortable working with Chinese language documents calling for China litigation on the other.  I would be remiss in mentioning that foreign (i.e., non-Chinese law firms) are allowed to participate much more actively in an arbitration than they are in a China court litigation, and so there is also oftentimes a split between those firms for whom international arbitration is a large part of their practice (they typically call for arbitration) and those firms for whom it is not.

And if the above is just not enough for you on China litigation versus China arbitration, I urge you to read the following:

Any questions?

I am constantly asked whether it makes sense to bother having a written contract with a Chinese company.  This question is usually followed by the statement that Chinese companies “never follow their contracts” or that “it is impossible to enforce a contract in a Chinese court, anyway.”

I always give the following answer:

It absolutely makes sense to have a contract with Chinese companies, and it makes sense for the following reasons:

1.  Clarity Before the Relationship Starts. A contract is the best way to make sure that you and the Chinese company with which you are contracting are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 30 days, it will say “yes” almost every time. But if you then put in your contract that the Chinese company must pay you a penalty if it fails to ship your product within 30 days, there is a very good chance the Chinese company will tell you that 30 days is impossible. At that point, you and the Chinese company should figure out realistic shipment dates and put that in the contract. You then know what is actually realistic to expect by way of shipment dates and you can act accordingly with your own customers. Spending the time to negotiate a contract with your Chinese counter-party, especially if that contract is in Chinese is the best way I know to achieve clarity before you lock yourself into a relationship.

2.  Stricture Having a well written contract (preferably in Chinese) that is at least arguably enforceable means that the Chinese company knows exactly what it must do to comply. And, in most cases, it might as well comply. Just by way of an example of how this works, assume that your Chinese company makes widgets for thirty foreign companies. Ten of those foreign companies have well crafted Chinese language contracts that set out very clear time deadlines with very clear liquidated damages provisions for failing to meet the time deadlines. Now let’s assume that the Chinese company starts falling behind on production.  To which companies do you think the Chinese company will give production priority? To the ten companies that are best positioned to sue it and win or to the twenty other companies? The Chinese company will of course put the ten companies with a good contract at the front of the line.

3.  Enforceability.  My firm has written hundreds of China contracts and yet I am not aware of even one time where our client has had to sue on one.  I attribute this to reasons one and two above. I use these numbers as proof that thoughtful and appropriate Chinese language contracts can prevent problems. I should note though that the World Bank ranks China 16th among 183  countries in terms of enforcing contracts. So it certainly is not unreasonable to think that if your Chinese counter-party believes a Chinese court or arbitral body will enforce your contract, or even if your Chinese counter-party simply believes enforcement is simply possible, it has real incentives to abide by your contract.

Not surprisingly, I am not the only person with the above views.  I just read a post on the Emerging Markets Insight Blog, entitled, “China’s channel challenge,” that lends strong support to the benefits of having a China contract.  The post is based on a meeting with “eight senior-most China executives from leading technology, healthcare, and industrial companies to discuss best practices for managing the channel and driving growth despite the headwinds.”

When it came to contracts with Chinese companies, all eight agreed that “the best practice is to more heavily invest in the negotiation, preparation, and enforcement of contracts.”  Even though Chinese companies do not view contracts the same way as Western companies, having a strong agreement “pays dividends”:

Local Chinese partners are more likely to view a contract as a roadmap than a strict and binary agreement.  And, every executive in the  room could share his own horror stories of partners violating contracts (or setting up new legal entities to skirt inconvenient agreements).  Although it may seem counter-intuitive to over-invest in contracts when there is little guarantee that partners will strictly adhere to them, a strong argument was made that investing the time and energy to structure a detailed contract can pay dividends, and furthermore, these contracts should be negotiated annually.

Chinese contracts. Well worth it.

What do you think?

Very interesting Wall Street Journal article on how Huawei Technologies Company, China’s hugely successful telecommunications- equipment maker, will be scaling back its dealing with Iran.

I see this as a potentially very important milestone in that it seems to indicate that in some circumstances, even Chinese companies widely believed to be “tight” with Beijing will place their profits over politics. One case does not a trend make, but most trends do start with one.

What do you think?

As we are always saying, you can win all the cases you want against Chinese companies in United States courts, but getting them to pay is another thing. Yet the march of Chinese companies to US stock market listings may be changing that ever so slightly. For small-time Chinese firms used to doing business on their own terms, often with little regard for contracts, this can be a radical realization.

This is what makes the spectacle of publicly traded Vision China Media’s (VISN) battles in the New York courts such a great test case.

Let me explain.

VisionChina’s business is those television screens playing advertisements in just about every elevator, bus and subway in China. This is an industry that has had some amazing revelations recently. Most notably, China MediaExpress (CCME) is facing so many fraud allegations, NASDAQ has halted trading in its stock (this is a fascinating story in its own right). Meanwhile, most every reputable company working for them has walked away. Fraud in Chinese reverse-listed companies has become almost expected, but VisionChina looks a bit different. It secured its NASDAQ listing by going the traditional IPO route and it is now being accused of simply refusing to pay for an acquisition.

In 2009, VisionChina agreed to buy DMG, an industry rival with a foothold in the subway sector. DMG was particularly appealing because it had just won the contracts for the Shanghai subway systems ahead of the 2010 Expo. The deal was structured so DMG’s investors would get $100 million in cash and stock at or about when the deal closed, along with two subsequent $30 million cash installments on each of the first two anniversaries of the closing date. In “Fear The China Joint Venture And Front-Load Your China Licensing Agreements,” we talked of the importance of front-loading payments in your China deals.

The public documents on the case go into too much detail to cover here, but the gist is that VisionChina put the first $100 million payment into escrow to be released a few months after closing and a large portion of that money was released as planned, with several more million of those escrow funds released a few months later.

After that though, things started getting sticky. VisionChina turned in a couple of very bad financial quarters and then it decided it wanted to re-negotiate its DMG deal. Not surprisingly, DMG had little interest in revisiting its already done deal with VisionChina. Then in August, 2010, VisionChina’s CFO, Scott Chen, resigned and VisionChina’s founder and CEO, Li Limin, had this to say in a press release:

Mr. Chen has made significant contributions to VisionChina Media’s financial management and investor relations. Additionally, he led our successful acquisition of Digital Media Group Limited in 2009 as well as the integration of the two companies. We are saddened by Mr. Chen’s decision to resign, but respect his wish to further pursue his career in investment banking. We are grateful to Mr. Chen for his service to the Company and wish him well in his future endeavors

Not exactly the words of a CEO firing his CFO in a fit of rage.

Now let’s fast forward to December 2010. VisionChina is already late on its second installment payment to DMG and it then pre-emptively(?) sues DMG’s investors claiming fraud. The fact that a Chinese company doing business exclusively in China chose to sue in New York is a testament in itself to the new calculation for US-listed companies.

VisionChina’s complaint sets out the following:

On December 24, 2009, just over a month after the Closing Date, VisionChina received Unaudited Interim Condensed Consolidated Financial Statements for the eight months from January 1, 2009 through August 31, 2009, which had been prepared by Ernst & Young (the “E&Y Report”). The E&Y Report revealed for the first time that DMG’s total revenue for the first eight months of 2009 – the period covered by the Management Accounts – was not RMB 104.7 millions, as represented.

*  *  *  *

[DMG’s investors] must have known that they were giving VisionChina false financial information during due diligence in order to induce VisionChina to enter into the Merger Agreement.

In other words, DMG’s investors misrepresented DMG’s financials. Well, maybe.

VisionChina apparently released tens of millions of dollars from escrow on January 2, 2010, more than a week after it said it received the E&Y Report. Then five months later, VisionChina released millions more. VisionChina apparently waited more than a year after reading the E&Y Report to bring its case against the DMG investors. I know nothing more about this case than what I have read in the public documents, but in my experience companies do not usually wait so long to sue in these sorts of circumstances; there is a saying in the legal business that debts do not get better with age.

In his affidavit, VisionChina’s former CFO, Scott Chen states:

I did not think at the time [of closing that DMG’s] revenue report was particularly impressive…I was primarily concerned  with verifying DMG’s subway contracts because of the strategic nature of the acquisition and DMG’s revenue stream was not the primary reason for the acquisition.

*  *  *  *

The [Ernst and Young] SAS 100 Report did not reveal any issues with the 2009 preliminary management accounts that would have prevented the closing of the acquisition of DMG.

At no time in the period between the signing the Merger Agreement and my departure in August 2010 did I participate in any discussions concerning any alleged fraud in DMG’s unaudited financial statements, nor was I aware of any such discussions.

Remember when Mr. Chen resigned in August 2010, VisionChina’s CEO, Li Limin, said he was “saddened” to see him go.

I’m looking forward to watching this case play out for three reasons:

  1. VisionChina is a Chinese company that listed on NASDAQ by way of a standard IPO. The prevailing wisdom says a company is more likely to be on the up and up if it goes through the more rigorous process involved with this type of listing.
  2. As a U.S. listed company, VisionChina has reasons to be concerned about an adverse New York court ruling and would likely face real consequences if it chooses not to abide by any decisions by that court.
  3. Given ChinaMedia Express’s recent near total collapse, I wonder what another market player taking a major hit will do to the Chinese media sector. I should stress, however, that unlike with ChinaMedia Express, I have seen no allegations that VisionChina is not a legitimate functioning company — merely that it is reneging on its contracts.

Perhaps, most interestingly, unlike many disputes between Chinese and foreign companies, this drama is going to play out in full public view. It should be interesting and I will be watching. No doubt there will be more lessons to be learned from this case.

What do you think?

Very few dispute that Chinese companies have a ways to go in building their brands globally.  Among China’s leading global brands there’s Lenovo and…..

Today’s People’s Daily has a story on how The World League of Productivity Science, the Chinese Association of Productivity Science and the Chinese delegates to the 14th session of the World Academy of Productivity Science (WAPS) announced the following ten companies as “China’s ten leading global brands in 2006:”

  • Baosteel
  • China Metallurgical Group Corp.
  • China National Offshore Oil Corp.
  • China National Heavy Duty Truck Group Co, Ltd.
  • Air China
  • China Life Insurance (Group) Company
  • FEIYUE Group
  • Datong Coal Mine Group Co., Ltd.,
  • Changan Automobile (Group) Co. Ltd.
  • Bosideng

You have got to be kidding.

How many people outside China have heard of even half of these companies?  My guess is less than 1%.  How many people in China have heard of half of these companies?  How many coal companies can you name?

The fact that these organizations (and I confess I have never heard of any of them) would name these ten companies as China’s leading global brands and the People’s Daily would do a story on it is further proof that China business has a long way to go in creating global brands.

Interesting article in the International Herald Tribune [link no longer exists] on the worldwide expansion plans of the Shangri-La Hotels and Resorts luxury hotel chain.  Shangri-La is based in Hong Kong, is majority controlled by the Kuok Group, founded by Malaysian billionaire Robert Kuok.  The Shangri-La group operates two brands: the five-star Shangri-La and the four-star Traders hotels.

Thrust of the story is an interview with Shangri-La’s chief executive, Giovanni Angelini, regarding Shangri-La’s taking its hotels to Asia and the United States and building its name there.   The company is the largest operator of luxury hotels in mainland China and is planning to double its current 20 hotels by 2010.  If you want an example of a company that understands what it takes to succeed at doing business in China, Shangri-La is it.

What I found fascinating about the article though, was Angelini’s views on the future of China travel.

“By the year 2020, it is expected there will be more than 100 million Chinese travelers,” he said. “Can you imagine the impact? Japan has made a tremendous impact in the industry and it never reached more than 17 million travelers.”

“If you go back 30 years ago,” Angelini continued, China is “exactly the way the Japanese were, traveling in groups around a little flag, negotiating the lowest rate. But look where the Japanese are now: in top hotels and big spenders. The Chinese market will be much stronger and develop much faster.”

I think he is absolutely right and I think what he says will apply to all industries. Right now, talk to anyone who provides high end legal, financial, public relations, design, consulting, advertising, or other kinds of business services in China and I can assure you will be able to get them to complain about the unwillingness of most Chinese companies to pay their fees.  Based on my own experiences in dealing with Korean and Russian companies over the last 15 years — as frustrated as I am — I am always counseling patience by saying “it will change.”

Mr. Angelini would agree.

Recent article on how China is now NASDAQ’s largest source of growth in new listings.  Mainland China companies now account for 29 of about 3,300 companies listed on NASDAQ, said the president of NASDAQ International, Charlotte Crosswell.  “The exchange also lists around 50 firms from Hong Kong, a Chinese special autonomous region, putting China third behind first-place Israel and second-place Canada in having the most non-U.S. listings on the Nasdaq, Ms. Crosswell said:”

Obviously the growth is coming from China, and that’s where we’re really seeing the pipeline expand, in terms of numbers of companies coming to market,” said Ms. Crosswell, who was in China’s commercial hub to encourage the parade of new Chinese firms marching toward listings on America’s largest electronic stock market.

The growth comes despite the potential disadvantage American exchanges face from the relatively strict rules on reporting and corporate governance required by the U.S. government.

This is all happening despite the U.S.’s 2002 enactment of the Sarbanes-Oxley Act, strengthening company oversight and reporting requirements:

However, Ms. Crosswell said Chinese companies tell her the regulatory hassles are offset by the added trust from investors. Chinese firms also have comparatively little difficulty implementing the requirements because they are often too young to have developed rigid corporate structures, she said.

“They believe it’s a good thing to have,” Ms. Crosswell said. “They’re actually very happy they can prove they can comply with it because they think that’s a good story for investors.”

Nasdaq listings from China traditionally have come from the high-tech sector, but they are now expanding to include services, manufacturing, health care and media, she said.

Color me skeptical, but I have a hard time believing there are many Chinese companies out there both capable and fully desirous of complying with rigorous U.S. transparency laws.  On the contrary, I see a growth industry in shareholder class action lawsuits against Chinese companies, starting very soon.

Update:  A reader directed my attention to a Wall Street Journal article, entitled, “Investing in China Demands Being Very, Very Careful, warning about many of the Chinese companies that do reverse mergers to go public in the United States.  Certainly worth reading.

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We frequently blog about increased Foreign Direct Investment by Chinese companies.  Our first post on this dealt with this issue generally, while our subsequent posts (here, here, and here) described specific examples.  We now have statistical proof of China companies increasing their outbound investments as China’s Ministry of Commerce announced today that foreign investment by Chinese companies was up 26 percent in 2005.